Update: Wow. I wish I had done a copy-paste, or even better, a screen shot of the original version of the article. When I originally posted this a bit over an hour ago, I can assure everyone that the table entry for Total International read as follows:

Now the article has silently changed, and points to FTSE Global All Cap ex US Index. So yes, they screwed up. Not sure I like this policy of silent corrections.

I'll leave my original post up, although it is now obsolete.

Original post:
The most puzzling one for me is Total International. According to the article, the new benchmark will be

FTSE All-World ex US Index

which just happens to be the same index used by, umm, the Vanguard FTSE All-World ex US Index fund (VFWIX/VFWAX/...).

So does that mean that Vanguard is planning to maintain two distinct index funds tracking the same benchmark? Seems pointless to me; surely one of the two funds ought to be closed.

And does it also mean Total International is losing access to small caps? Rather disappointing if that's the case. I'd rather spend an extra basis point -- 7 million dollars -- if that's what it takes to continue using an index that includes small caps.

Elsewhere in the article there is a clue suggesting that perhaps the reference to the FTSE All-World ex US Index benchmark is an error.

The benchmarks for Vanguard Target Retirement Funds, Vanguard LifeStrategy® Funds, Vanguard Managed Payout Funds, and two insurance/annuity portfolios will also be changing. For these funds-of-funds, the FTSE Global All Cap ex US Index and CRSP US Total Market Index will replace the MSCI All Country World ex USA Investable Market Index and MSCI US Broad Market Index components of the composite indexes.

These funds contain Total International; notice that the bolded part is a new index that might plausibly include small caps.

If it is an error in the announcement, it's a pretty bad one IMO.

Last edited by House Blend on Tue Oct 02, 2012 9:19 am, edited 1 time in total.

I am going to play boglehead and ask someone else to look something up for me.

Total Market is going from a "Broad" index to a "Total" index (there was a recent post noting the distinction - I could guess at the name of the poster without looking, but that would be a disservice if I got it wrong, and the whole purpose of this post is to write without actually looking up the facts).

So how total is the CRSP US Total Market Index? (with apologies to, now I am guessing, Gordon, aka GKaplan, for starting a question with "so")

This is good news, they are moving more towards indexes that are investment friendly (reconstituted more often, trade more patiently, keep changes private, etc.). Take a look at my posts--I usually use CRSP 1-10 as my TSM Index--it is the academically accepted definition of the market.

All in all, however, no reason to anticipate big changes to either TSM or style indexes.

Baer Pettit, Head of MSCI’s Index Business, said, “We are disappointed that Vanguard will no longer use our indices as the basis for these exchange traded funds. The ETF market in North America is competitive and as it evolves, we will work with those ETF providers who seek to utilize independent, well-respected, and high-quality equity indices in their products. MSCI indices have been developed over 40 years to meet the specific needs of the world’s most demanding and sophisticated investors.”

Apparently thats the sound of about $25M in annual licensing revenue departing MSCI.

It means the emerging market fund will lose South Korea, which is the 2nd largest country in the fund with a 15% weight. Maybe not all at once to minimize turnover but over time. IIRC the FTSE index does not include South Korea as an emerging market.

Jerry_lee wrote:This is good news, they are moving more towards indexes that are investment friendly (reconstituted more often, trade more patiently, keep changes private, etc.). Take a look at my posts--I usually use CRSP 1-10 as my TSM Index--it is the academically accepted definition of the market.

All in all, however, no reason to anticipate big changes to either TSM or style indexes.

tfb wrote:It means the emerging market fund will lose South Korea, which is the 2nd largest country in the fund with a 15% weight. Maybe not all at once to minimize turnover but over time. IIRC the FTSE index does not include South Korea as an emerging market.

tfb wrote:It means the emerging market fund will lose South Korea, which is the 2nd largest country in the fund with a 15% weight. Maybe not all at once to minimize turnover but over time. IIRC the FTSE index does not include South Korea as an emerging market.

tfb wrote:It means the emerging market fund will lose South Korea, which is the 2nd largest country in the fund with a 15% weight. Maybe not all at once to minimize turnover but over time. IIRC the FTSE index does not include South Korea as an emerging market.

Jerry_lee wrote:This is good news, they are moving more towards indexes that are investment friendly (reconstituted more often, trade more patiently, keep changes private, etc.). Take a look at my posts--I usually use CRSP 1-10 as my TSM Index--it is the academically accepted definition of the market.

All in all, however, no reason to anticipate big changes to either TSM or style indexes.

How does keeping changes private make investing better?

It stops other investors from knowing trades you're going to make and trading ahead of you, thereby profiting at your expense.

This seems like it will make it difficult to maintain my target market cap weightings.

I try to be cap weighted between domestic/intl split. In the TSP I have access to the I Fund, and Vanguard MSCI Emerging Markets (VWO) was a natural complement. Now it seems like I will be missing South Korea unless I use a different ETF.

Since Vanguard plans to use FTSE Global All Cap ex US Index for Total US, I would feel better if it went with FTSE US All Cap for the Total International. I'm sure it doesn't matter too much and that CRSP is fine but the anal part of me would like it better.

Last edited by Gauntlet on Tue Oct 02, 2012 9:10 am, edited 1 time in total.

Jerry_lee wrote:This is good news, they are moving more towards indexes that are investment friendly (reconstituted more often, trade more patiently, keep changes private, etc.). Take a look at my posts--I usually use CRSP 1-10 as my TSM Index--it is the academically accepted definition of the market.

All in all, however, no reason to anticipate big changes to either TSM or style indexes.

How does keeping changes private make investing better?

It stops other investors from knowing trades you're going to make and trading ahead of you, thereby profiting at your expense.

That makes sense. It appears though that the CRSP allows stocks to be part of multiple indices, i.e. they don't have sharp boundaries between categories. Plus it sounds like they will change their indices randomly in time. Those methods should mostly eliminate front-running and allow them to be more open about the content of the indices.

At least on the domestic side, this change seems decent (not earth shattering) and front-running issues will be mitigated somewhat. Also, it looks like the potential for deep-value indices (and deep growth) being offered down the road via CRSP could be a possibility - perhaps Gus will pull the trigger, perhaps not.

I'm a little less clear on Total International rationale, if smaller caps are removed, would that offset cost savings? Edit - read the change in above post that went to all-cap.
I wonder if Vanguard will reduce the ER's due to lower licensing fees, less trading and so on...... Perhaps a shot across the bow with respect to Schwab's recent announcement?

Ketawa wrote:This seems like it will make it difficult to maintain my target market cap weightings.

I try to be cap weighted between domestic/intl split. In the TSP I have access to the I Fund, and Vanguard MSCI Emerging Markets (VWO) was a natural complement. Now it seems like I will be missing South Korea unless I use a different ETF.

Plus you are already missing Canada, which will still be missing from VG's Developed Market fund.

Puzzled by the international change too and what it means. My main concern would be maintaining the ability to tax loss harvest between VEU/VXUS as those are the core of my taxable accounts. I think this tax loss harvesting would still be allowed given the change.

"New investable indexes, from the Center for Research in Security Prices at the University of Chicago or CRSP, could reduce compulsory trading for any index funds that adopt them as a benchmark. Funds that trade less should have lower brokerage costs, lower tax bills and higher net returns. Better yet, it should be harder for outsiders to front run these improved indexes."

"MSCI understands that Vanguard will begin to transition these funds in January 2013 and the transitions will be staggered over a number of months. MSCI’s annualized revenue and operating income associated with the Vanguard funds being transitioned are approximately $24 million."

"Fund benchmark changes should create savings for shareholders. By negotiating favorable licensing agreements with these benchmark providers, Vanguard expects to pass on significant savings over time in the form of lower expense ratios for the funds."

Ketawa wrote:This seems like it will make it difficult to maintain my target market cap weightings.

I try to be cap weighted between domestic/intl split. In the TSP I have access to the I Fund, and Vanguard MSCI Emerging Markets (VWO) was a natural complement. Now it seems like I will be missing South Korea unless I use a different ETF.

Plus you are already missing Canada, which will still be missing from VG's Developed Market fund.

Very true, I completely forgot about that. It seems the I Fund was incepted on May 1, 2001. I wish the TSP would make a transition to a broader international fund.

Jerry_lee wrote:This is good news, they are moving more towards indexes that are investment friendly (reconstituted more often, trade more patiently, keep changes private, etc.). Take a look at my posts--I usually use CRSP 1-10 as my TSM Index--it is the academically accepted definition of the market.

All in all, however, no reason to anticipate big changes to either TSM or style indexes.

Jerry, I am particularly interested in the LV, MV, and SV offerings. Some questions for you or others:
1) Is there a free source of monthly data going back several years so one could compare MSCI and CRSP behaviour?
2) Do MSCI indexes have different sector representations then CRSP, i.e. will SV change quite a bit in it's make up?
3) Do you think that this MSCI to CRSP change will affect factor exposure a lot in LV, MV, or SV?

NewtonsApple wrote:Puzzled by the international change too and what it means. My main concern would be maintaining the ability to tax loss harvest between VEU/VXUS as those are the core of my taxable accounts. I think this tax loss harvesting would still be allowed given the change.

Sounds like there was a typo in the earliest release. Two people here thought it did not include small cap.

If readers would read House Blend's original post at the top of this thread, with and without the update, they will see that that is exactly the case. House Blend posted the very first response and pointed out the apparent error, apparent even at 8:00 am Eastern.

Edit added: For all we know, someone from Vanguard reads bogleheads and saw that House Blend had spotted their error. Perhaps the reason it is fixed now is because of House Blend's keen eyes and good reading skills.

Last edited by sscritic on Tue Oct 02, 2012 9:56 am, edited 1 time in total.

The nice improvement is that now the reconstitution is done quarterly.

On page 19 (Chapter 5) you can also read about the Value/Growth factors which are also based on multi-factors. At first glance I don't see a whole lot of difference in terms of how MSCI and CRSP uses the multi-factors to determine value/growth.

The interesting thing I read was the part about how a stock could migrate from say Value to Growth --- but what they will do first is only move 50% of the stock weight to the new category as a transitionary period because it might just be a temporary blurp. So there will be periods when stocks can be partially in both value and growth indices. If the stock can sustain itself in the new category at the next reconstitution then it will fully move over.

NewtonsApple wrote:Puzzled by the international change too and what it means. My main concern would be maintaining the ability to tax loss harvest between VEU/VXUS as those are the core of my taxable accounts. I think this tax loss harvesting would still be allowed given the change.

Jerry_lee wrote:This is good news, they are moving more towards indexes that are investment friendly (reconstituted more often, trade more patiently, keep changes private, etc.). Take a look at my posts--I usually use CRSP 1-10 as my TSM Index--it is the academically accepted definition of the market.

All in all, however, no reason to anticipate big changes to either TSM or style indexes.

How does keeping changes private make investing better?

So you cannot front run them. When index providers pre-announce changes (stocks to be added/deleted from an index), it creates artificial upward and downward price pressure on the corresponding companies. Short-term traders will buy stock entering and short stocks leaving prior to reconstitution date, effectively earning the spread between the two. So if you can help it, don't announce changes until after they've been implemented. If you have to, as a fund, don't act on the changes for a month or two -- at that time, artificial movements revert to normal trading. Vanguard and DFA have been doing this with their S&P 500 funds for years, which is why, net of expenses, they are able to match/exceed the return on the S&P 500.

NewtonsApple wrote: My main concern would be maintaining the ability to tax loss harvest between VEU/VXUS as those are the core of my taxable accounts. I think this tax loss harvesting would still be allowed given the change.

I am confused by what you wrote here. Do you think these will still be safe as TLH partners?

Like Newton Apple, these 2 funds are my entire taxable account and are TLH partners whenever the international market tanks.

In my opinion, TLH between the two would still be allowed as the funds are significantly different. Boglenaut is just pointing out that you can better equate VEU to VXUS by adding small caps (VSS). I don't even bother with this to keep it simple. My default buy is VXUS. If I need to TLH, I move to VEU. I don't plan to ever move the money back to VXUS unless there is another TLH opportunity. VEU is close enough to VXUS for my taste. The majority of my money will end up in VXUS hopefully anyways.

Jerry_lee wrote:This is good news, they are moving more towards indexes that are investment friendly (reconstituted more often, trade more patiently, keep changes private, etc.). Take a look at my posts--I usually use CRSP 1-10 as my TSM Index--it is the academically accepted definition of the market.

All in all, however, no reason to anticipate big changes to either TSM or style indexes.

Jerry, I am particularly interested in the LV, MV, and SV offerings. Some questions for you or others:
1) Is there a free source of monthly data going back several years so one could compare MSCI and CRSP behaviour?
2) Do MSCI indexes have different sector representations then CRSP, i.e. will SV change quite a bit in it's make up?
3) Do you think that this MSCI to CRSP change will affect factor exposure a lot in LV, MV, or SV?

Personally, I don't have any answers -- haven't seen any simulated data. I have a very high opinion of CRSP, and when I looked at index construction a while back, they looked very similar to MSCI indexes. The small break seemed to be a bit smaller (2% to 15%) and extend further into micro cap, but beyond that, I didn't see any major differences. I did notice CRSP had developed a "small cap ex. REIT" index, and unfortunately I doubt Vanguard would use it, but they should.

If the new Small Value index has a slightly smaller buy range, say similar to DFA US Targeted Value (buys the smallest 15% of stocks), then assuming 1000+ holdings or somewhere in that vicinity, I'd want to own this thing instead of Russell 2000 Value or S&P 600 Value. For return purposes, here are the simulated and out-of-sample live returns on CRSP 1-10 (Vanguard TSM) and DFA Targeted Value Index (DFA Targeted Value Fund) from '28-9/'02 and 10/'02-9/'12:

1/1928 = 9/2002
CRSP 1-10 Index = +9.5%
TV Index = +13.0%

10/'02 - 9/'12
Vanguard TSM = +8.6%
TV Fund = = +11.6%

So you see, whether simulated or live, a value portfolio of the bottom 15% of companies can be expected to produce about a 3% return in excess of the market (size/value factors will probably be in the 0.6/0.6 range).

Baer Pettit, Head of MSCI’s Index Business, said, “We are disappointed that Vanguard will no longer use our indices as the basis for these exchange traded funds. The ETF market in North America is competitive and as it evolves, we will work with those ETF providers who seek to utilize independent, well-respected, and high-quality equity indices in their products. MSCI indices have been developed over 40 years to meet the specific needs of the world’s most demanding and sophisticated investors.”

Apparently thats the sound of about $25M in annual licensing revenue departing MSCI.

The transition to the new benchmarks is not expected to result in capital gains distributions to the Vanguard funds’ shareholders, according to a press release.

Can't see how they'll accomplish that unless the indexes are quite similar.

In the Announcement:

Capital gains are unlikely
We don't expect any capital gains distributions to shareholders to result from the transition to the new benchmarks. Each affected fund currently has realized capital losses that can be used to offset any realized gains.

The transition will require some turnover of holdings and result in transaction costs during the transition. However, Vanguard Equity Investment Group, as manager of these funds, will work to minimize trading impact through efficient portfolio trading as well as other time-tested strategies used during periodic index rebalancing.

CRSP being the Center for Research in Security Prices, an extension of the University of Chicago Business School named after David Booth? Booth of course gave away much of his wealth to UoC, which no doubt is used for research efforts, some of which I'm sure have gone into the development of these indexes.

On the other hand MSCI has around 9,000 positions, while FTSE has only about 5,300.

The only thing that concerns me is the 5yr total return of the FTSE Index as of Q3 2012 was -15.7% annually (the index incepted on 9/1/2003, and the earliest they indicate we are likely to get 10 year returns seems to be at the end of next quarter). In contrast, MSCI posted a 5yr of -2.97% through Aug. 2012 (Q3 data doesn't seem to be out yet). I don't believe anything happened in Sept. that's going to cause MSCI to shift it's quarter-end number dramatically downwards.

Curious to know:
1. If anyone has access to Q2 data for both indexes while we await Q3 data.
2. What would cause the difference in performance.

Edit: Found 9/30/12 1yr performance: FTSE posted 15.1%, while MSCI posted 14.36%. I would have expected the longer term performance to be similar as welll.